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Forgiven debt or a gift?

By Kay Bell ·
Thursday, November 15, 2012
Posted: 4 pm ET

Remember Occupy Wall Street? After staging protests nationwide to protest greed and corruption in the financial sector, it has branched out to more public service activities.

The group's latest effort is still financially focused, but its latest targets are not high-powered financiers. They're regular people, the 99 percent, who are deep in debt.

Through its new project Rolling Jubilee, the Occupy folks plan to randomly buy securitized debts from creditors on pennies on the dollar and then write it off.

That's right. If Occupy buys your $5,000 Visa bill for $100, then you no longer have to worry about that bill. Unlike the debt collectors who usually purchase these amounts and then contact you constantly for payment, Occupy doesn't want your money. It just wants, according to its Rolling Jubilee website, to abolish debt "at random through a campaign of mutual support, good will, and collective refusal."

Occupy is holding a Rolling Jubilee fund drive to raise cash to buy consumer debt and then forgive it.

Good for Occupy for finding another cause.

Good for those folks whose debt is selected for elimination.

And maybe good for the Internal Revenue Service.

Forgiven debt tax rules

When you owe a creditor but you just can't pay the bill in full, that creditor (such as the Visa issuer mentioned in the earlier example) might accept a portion of the debt and write off the balance. When that happens, the amount it writes off is known as "forgiven" or "canceled" debt.

Sounds good, right? Except for the fact that the Internal Revenue Service considers the amount you didn't have to pay as cancellation of debt, or COD, income.

And we all know what the IRS does with income. It collects tax on it.

In most instances, when debt is canceled the creditor sends the debtor a Form 1099-C reporting the amount that was forgiven. The IRS gets a copy of the form. In the example, the $5,000 debt Occupy bought for $100 and then writes off could produce $4,900 in COD income for the debtor.

Before tax-savvy Bankrate readers shoot off emails, yes, I know there are forgiven debt exceptions, such as on certain mortgage amounts as well as for individuals who are bankrupt or insolvent.

But those are extreme circumstances, and in most cases that $4,900 would be reported by the debtor in addition to other income when he or she files that year's tax return.

So the IRS could be another beneficiary of the Rolling Jubilee. Or not.

Nontaxable gifts?

There's a debate going on in the tax world right now as to whether the Occupy program would technically produce what the IRS considers canceled debt income.

Occupy says via an online Rolling Jubilee fact sheet that since the group will not earn any income from the lending of money, it is exempt from filing a Form 1099-C under the Internal Revenue Code.

Under this approach, Occupy is basically making a gift to the debtor in the form of buying his or her debt at a discount and then discharging the remainder. And when someone gives another person a gift of money, there's not tax consequence for the recipient.

But is it really a gift?

Other, more cautious tax gurus are dubious. "The fact that a lender does not issue a Form 1099-C does not determine whether or not the transaction is taxable," Jim Buttonow, a CPA and former IRS examiner, told the Huffington Post. So just because Occupy doesn't plan to issue a 1099-C doesn't necessarily mean the forgiven debt isn't taxable.

Tax attorney David Miller suggested to Bloomberg Businessweek that Occupy Wall Street form a tax-exempt 501(c)3 organization to negotiate directly with credit card companies on behalf of individual debtors and structure the Rolling Jubilee payments as grants.

That tax code charitable designation also would be helpful to folks who want to contribute to the cause. Occupy is asking for donations to its strike debt fund, and you and I can only deduct gifts that go to IRS-approved groups.

Because Occupy is a 501(c)4, a nonprofit tax structure that allows it to allow lobby for causes, our donations to it are not tax-deductible. If it were, however, a 501(c)3 then we'd be able to deduct our donations.

All these questions about Rolling Jubilee and potential tax complications for the folks Occupy is trying to help are, of course, in the often debatable world of tax policy.

Let's move to real tax life.

If Occupy doesn't issue 1099-C forms to lucky Rolling Jubilee recipients to alert them to the forgiven debt amount, the chances that they will report it as income on their tax returns is negligible.

And the chances of the IRS, without its copies of the 1099-Cs, coming after those now debt-free folks are even smaller.

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November 17, 2012 at 11:23 am

From the hospital's perspective, there is no difference between what happens today via Occupy and what happened yesterday, before the Rolling Jubilee existed. The Jubilee is buying medical debts that have already been written off by the hospital.

From the hospital's perspective, this works exactly the same way as when they sell the debt to any other debt collector. The hospital sells the debt to the collector, then deducts the difference from hospital's taxes. The hospital does not "fail" - it's just business as usual for them.

The only party for whom there is a change is the person who had cancer, or a heart attack, or some other major life event that their insurance chose not to cover. 80% of medical bankruptcies in the US occur in cases of people who *have* insurance, but whose insurance does not cover the necessary care in high cost situations. 60% of *all bankruptcies* in the US are medical bankruptcies.

The hospitals will be fine, and the economy will be in better shape when people no longer have tens of thousands of dollars of medical debts hanging over their heads, ruining their credit ratings.

When they work out some legalities, they will also buy the student loan debt of students who got snookered by crooked lenders during the time window when for-profit student lending with usurious interest rates was allowed. Unfortunately, for those students, when the law was changed to allow such loans, laws were also passed to make student loan debt non-dischargeable via bankruptcy. This will give these college graduates the chance to start saving, which in turn will lead to the ability to buy homes, which in turn will aid the economy a few years down the road by improving housing demand, thus ending the housing slump.

The rules of supply and demand still hold. As long as we crush demand by not freeing up capital in the demand side of the economy, the supply side will be looking for buyers and not finding them. The demand side of the economy has been ignored for too long. This will free up capital in the demand side of the market.

November 16, 2012 at 10:55 am

So what happens to the economy when all the debt these people have to their name is suddenly forgiven and the companies standing behind that debt are forced to fail? Why can these people not take responsibility for their own actions? Why are they going to be forgiven with 60 in TVs in their living rooms? Why should those who make good choices pay for those who make bad choices? STOP PUNISHING PEOPLE WHO THINK BEFORE THEY ACT TO REWARD THOSE WHO ACT BEFORE THEY THINK!